With all the major frac sand (proppant) producers having reported stellar numbers, including Select Sands today, now it’s time to dig into why these sand miners are still hated so much.
Obviously, analysts like the net income/ positive EBITDA reported by our big four miners (EMES, FMSA, SLCA, and HCLP), and the outstanding earnings visibility that they have until the end of 2018 (assuming oil prices stay in the same range).
Obviously, analysts like the healthy industrial sales of these miners, too (except HCLP, of course).
So, why the continued sell-off?
If it’s not the surging frac sand sales, or solid industrial sales, then the reason analysts hate the frac sand miners must be because of the sector itself.
Of course, oversupply is coming right?
Wrong. Additional supply is coming, but…
Only in a way that benefits our big four sand miners, actually; not in a way that hurts them.
1.) Local, Brown Sand Makes Big Four Miners Stronger
Now that the big 4 have acquired more mining rights in Texas, their superior logistics networks and full suite of sand services will prevail; their new mines will allow them to take market share from the smaller, new Texas miners (brown sand) ALONG with the smaller, high cost miners in Wisconsin (tier 2 producers).
The consensus among the big four sand miners after earnings was that they will stay MORE than competitive in tomorrow’s frac sand market. But, the tier 2 producers will get “pushed up the cost curve”.
We already wrote some about how the big four miners are superior choices compared to the tier 2 competitors in Wisconsin and the Permian for a number of reasons, listed here: Why we like shale, and frac sand players.
But, if you had a publicly traded oil company which can’t afford mistakes, wouldn’t you pick a sand supplier that is safer, more reliable, and cheaper? Yes. You would choose one of the big four every time, unless there was a shortage.
This is why they will get stronger, and take market share from the smaller guys.
2.) 100 Mesh Pricing Will Suffer First, Suffocating Tier 2 Miners
We know that demand for frac sand is exceeding supply, in most grades (particularly the finer grades- 100 mesh, and 40/70).
So, the extra 15-25 million tons realistically expected to come online between now and the end of 2018 (55 million total tons have been announced, but unlikely to materialize due to permit issues, inexperience, etc.), is necessary to meet strong demand.
But, whatever extra supply comes on in the Permian, beyond the 15-25 million tons, will probably be needed, anyway, to meet the robust demand forecasted in 2018 (between 110-150 mil tons).
Consequently, whatever extra supply remains unsold will have to compete on the spot market, since all of the good contracts will be gone.
So, with this excess sand competing on the spot market, I could understand people’s oversupply fears- who don’t know the whole story.
Grade Mix, Quality, & Reduced Rail Costs Will Actually TRAP Brown Sand Miners, & Phase Out Tier 2 Wisconsin (Northern White Sand) Miners
Remember that only two grades of sand can be produced in the Permian 40/70, and 100 mesh, discussed here: http://wallstreetstocksolutions.com/8020-rule-frac-sand-supply-myths-debunked/.
If only two grades can be mined in the Permian, and the majority of sand produced there will be 100 mesh (80%), then there could be some pricing pressure on 100 mesh white AND brown, since there is plenty of 100 mesh being produced (80% of the announced 55 mil tons will be 100 mesh, while the other 20% will be 40/70).
Since drillers want a complete and reliable sand source, and won’t just rely on a single, brown or white 100 mesh source, the big four miners will continue to pump 100 white into the Permian along with coarser grades of white sand needed for complex wells.
So, sales of 100 white will perhaps plateau, along with pricing. But, those lost sales and diminished pricing experienced by the big four, will be offset by gains in their new brown sand (which have higher margins than white).
This “weeding out” event of higher cost (tier 2) 100 mesh miners, for both white and brown producers, will increase the tier 2 miner’s likelihood of bankruptcy, as decreased sales, volumes, and pricing will lead to increased fixed costs- eating into margins.
In other words, the marginalizing of 100 mesh brown and white producers, who don’t have the logistics network/experience to compete with the big four, will play directly into the big four’s hands.
As the smaller guys in Wisconsin go bankrupt, their clients from other basins NOT served by Permian sand will have to go to the big four. The brown sand miners will not get the displaced, white sand customers, because Texas sand CANNOT LEAVE TEXAS (or rail advantage is lost).
The purpose of cheaper, local sand would be defeated if it had to be railed to the rest of the country; the $50 cost savings avoiding rail would be gone, and the brown sand, after all, is inferior.
So, why would a driller in the Bakken or Marcellus choose inferior (but about same cost) Texas sand, where a higher strength/quality proppant is needed for deeper wells in the Bakken and Marcellus anyway?
Analysts have overreacted to the new supply being added- it is needed to meet forecasted demand.
However, if these “worst-case” scenarios playout to fruition (all 55 mil tons of limited grades and inferior quality added), then the big four will only get stronger as their expertise and superior scale allows them to take market share from competitors.
As the smaller guys get phased out towards bankruptcy, losing their Northern White clients to the big four miners, the smaller miners in Texas, meanwhile, won’t acquire the displaced, Northern White customers either, since their sand doesn’t have the quality, grade size, or ability to be railed to the rest of the country.
The big four have just bifurcated the sand market into two segments essentially, brown and white, and their superior position in the frac sand space promises a bright outlook for them in 2018 and beyond.
This article is being written contrary to popular belief. But, hopefully more education on the frac sand industry will finally turn the skeptics into believers, and get our portfolio back into the green.